Transcript Chapter 14

Chapter 14
Environmental Economics
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What assumption is
made in this chapter?
There is sufficient foreign
and domestic competition
to allow us to use the
perfectly competitive model
2
When does economic
efficiency exist?
Efficiency exists when the
price to consumers,
reflecting marginal benefit,
equals marginal cost
3
Who is a third party?
People outside the
market transaction who
are affected by the
product
4
What are private
benefits and costs?
Benefits and costs to
the decision maker,
ignoring benefits and
costs to third parties
5
What are externalities?
Benefits or costs that
are not considered by
market buyers and
sellers
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What is an example
of an externality?
Air pollution is an
externality that affects
third parties not driving
automobiles
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What is an example of
a positive externality?
The enjoyment you derive
from your neighbors wellkept yard
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What happens
when externalities
are present?
Competitive markets
are not likely to
achieve economic
efficiency
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What are
social benefits?
The sum of benefits
to everyone,
including both
private benefits and
external benefits
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What are private costs?
Production costs of
capital, labor, land,
and entrepreneurship
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What are social costs?
The sum of costs to
everyone, including
both private costs
and external costs
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When is social
welfare maximized?
It is achieved when
marginal social
benefit equals
marginal social cost
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Why can’t
businesses acting on
their own solve the
problem of pollution?
The added costs of cleaning
up the environment will
make them less competitive
in the market place
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What may happen to a
firm that takes on the
added costs of antipollution devices?
They eventually will be
driven out of business
by lower cost firms
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The following graphs show
the short-run marginal cost
curves and the long-run
average cost curves for two
firms; one pays private
costs (typical) and the other
pays both private and
external costs (green firm)
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P
Short-run Marginal Cost
PMC (typical)
SMC (green)
PSR=SRPMC
QS
QP
Q
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P
Long-run Average Cost
SAC (green)
PLR=LRSAC
PAC (typical)
PLR=LRPAC
QLR
Q
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What happens
when external
costs are ignored?
Competitive firms
produce “too much,” and
the market equilibrium
price is “too low,”
compared to a socially
efficient industry
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P
Comparisons of Equilibriums for Typical
Competitive and “Green Industries”
SS =  SMC
(green)
PS
PS =  PMC
(typical)
PC
D
QS
QC
Q
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Do markets fail
when externalities
are present?
Externalities illustrate
that private markets fail
to produce society’s
preferred outcome
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How can society
achieve efficiency
when markets fail?
Government has a
potential role when
there is market failure
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What is an example of
government failure?
Government can fail to
correct market failure
by doing too little or too
much about pollution
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What are two
government
approaches?
• Incentive-based regulations
• Command-and-control
regulations
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What is a commandand-control regulation?
Government regulations
that set an environmental
goal and dictate how the
goal will be achieved
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What is an example
of a command-andcontrol regulation?
Mandatory installation of
catalytic converters on
automobiles
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What is an incentivebased regulation?
Government regulations
that set an environmental
goal, but are flexible in
how buyers and sellers
achieve the goal
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What is an
effluent tax?
A tax on the pollutant
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P
Using an Effluent Tax to Achieve
Environmental Efficiency
SS =  (MC, t)
(green)
tax
PS
PS =  MC = 
PMC
(typical)
Pc
D
QS
QC
Q
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What is
emissions trading?
Trading that allows
firms to buy and sell
the right to pollute
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What is
new-source bias?
Bias that occurs when
there is an incentive to
keep assets past the
efficient point as a result
of regulation
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Is the efficient
amount of pollution
typically zero?
No, the marginal social
cost of achieving one
more unit of clean air may
be greater than the
marginal social benefit
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What is the
Coase Theorem?
The proposition that private
market negotiations can
achieve social efficiency,
regardless of the initial
definition of property rights
33
How comprehensive is
the Coase Theorem?
Only a small number of
environmental problems
qualify for Coase
Theorem solutions
34
Which cases qualify for
the Coase Theorem?
• no transaction costs
• no income effects
• only two parties in
the negotiation
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What is a
transaction cost?
The costs of negotiating
and enforcing a contract
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What is the
free-rider problem?
If some people benefit
while others pay, few
will be willing to pay
for improvement of
the environment or
other public goods
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What is the result of
the free-rider problem?
Goods affected are
underproduced
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Key Concepts
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Key Concepts
•
•
•
•
•
•
•
•
•
When does economic efficiency exist?
Who is a third party?
What are private benefits and costs?
What are externalities?
What are social benefits?
What are private costs?
What are social costs?
Where is social welfare maximized?
Why can’t businesses action on their own
solve the problem of pollution?
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Key Concepts cont.
• How can society achieve efficiency when
markets fail?
• What is a command-and-control
regulation?
• What is an incentive-based regulation?
• What is an effluent tax?
• What is emissions trading?
• What is new-source bias?
• What is the coase theorem?
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Summary
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Externalities are benefits or
costs that fall on third parties
who are neither buyers nor
sellers. Pollution is a negative
externality or external cost that is
a byproduct of many industrial
production processes.
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Market failure is present when the
market produces a socially
inefficient outcome. One instance is
when there are externalities All
firms , including competitive firms,
consider private costs, but
disregard external costs, in making
decisions
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Government failure occurs when
public-sector actions move us
away from desired outcomes,
such as efficiency. Government
officials seeking campaign
contributions and votes may
choose environmental measures
that favor wealthy contributors
over society’s best interests.
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Command-and-control regulations
occur when the government
dictates the approach to achieving
an environmental goal.
46
Command-and-control (CAC)
regulations are generally
inefficient on three grounds: They
do not distinguish between high
and low pollution areas, they do
not allow firms to choose lower
cost technologies that could
achieve the environmental
standard, and they do not
encourage improved technology
to lower future emissions.
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Incentive-based regulations build
on markets to achieve
environmental efficiency. Effluent
taxes are taxes that reflect
external costs. Emissions-trading
allows firms to buy and sell the
“right to pollute.”
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The Coase Theorem maintains that
markets can be efficient in the
presence of externalities with
minimal government intervention.
Even in the presence of externalities,
markets may produce efficient
outcomes so long as property rights
are clearly established.
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Transactions costs, income
effects, and free-rider
problems are obstacles to
achieving environmental
efficiency through markets.
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Transactions costs are the costs
of negotiating an agreement
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Income effects are present when
limited income prevents one
party from being able to afford
the efficient solution
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Free-rider problems are present
when participants are better off
hiding than revealing their
willingness to pay for an
environmental improvement
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Chapter 14 Quiz
©2002 South-Western College Publishing
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1. New Orleans discovered chemicals in its
drinking water. The source is the waste
discharges of industrial plants upstream.
This is an example of
a. an external cost imposed on the
citizens of New Orleans by the
industrial plants upstream.
b. a market failure where the market
price of the output of these industrial
plants does not fully reflect the social
cost of producing these goods.
c. an externality where the marginal
social costs of producing these
industrial goods differ from the
marginal private costs.
d. all of the above.
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1.
D. The upstream firm is releasing
chemicals into the water, an external
cost to the citizens of New Orleans. The
upstream firm is not including these
costs when pricing its product; hence,
the market price is too low. Marginal
social costs would include the marginal
private cost of the industrial product
(their costs of labor, capital, materials,
etc.) and the external cost of the
chemicals released into the water.
Choices (a), (b), and (c)each are correct,
so that all of the above is the correct
choice.
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2. A government policy that charges steel
firms a fee per ton of steel produced
(an effluent charge) where the fee is
determined by the amount of pollutants
discharged into the air or water will
lead to
a. a decrease in the market equilibrium
quantity of steel produced.
b. a decrease in the market price of
steel.
c. an increase in the market price of
steel.
d. the results in (a) and (b).
e. the results in (a) and (c ).
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2.
E. Essentially, the government is
employing an effluent tax to reduce
pollution. The tax increases the cost of
production. Supply decreases, leading
to a higher price and smaller quantity.
So choice (e), where (a) quantity
decreases and (c)price increases, is the
best choice.
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3. Social costs are
a. the full resource costs of an
economic activity.
b. usually less than private costs.
c. the costs of an economic activity
borne by the producer.
d. all of the above.
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3.
A. Social costs include both private costs
(the costs of the firm’s inputs, including
labor, capital, land, etc.) and external
costs (the costs to third parties, such as
pollution emitted by the producer).
Social costs are at least as large as
private costs. Producers will not
consider external costs, which are a part
of social costs, unless they are forced to
do so by government or court.
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4. As a general rule, if pollution costs
are external, firms will produce
a. too much of a polluting good.
b. too little of a polluting good.
c. an optimal amount of a polluting
good.
d. an amount that cannot be
determined without additional
information.
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4.
A. Private firms will make their production
decision using private costs. If there are
external costs, social costs exceed
private costs. If production decisions
included external costs, supply would be
smaller than when private costs alone
are considered. So if external costs are
ignored, the firm will produce too much,
as compared to the social efficient level.
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5. Many economists would argue
a. the optimal amount of pollution
is greater than zero.
b. all pollution should be
eliminated.
c. the market mechanism can
handle pollution without any
government intervention.
d. central planning is the most
efficient way to eliminate
pollution.
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5.
A. The optimal amount of pollution is
where marginal social cost equals
marginal social benefit. This amount
typically exceeds zero. The marginal
cost of eliminating all pollution would
likely be very high. For example, we
would have to eliminate all cars.
However, firms tend to ignore external
costs such as pollution, in an unfettered
market. While government is likely to be
needed, pollution has actually been
worse in centrally planned economies.
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6. Which of the following used
marketable pollution permits as an
incentive for reducing pollution?
a. The 1970 Clean Air Act.
b. The Comprehensive
Environmental Response,
Compensation, and Liability Act of
1980.
c. The 1990 Clean Air Act
amendments.
d. The Water Quality and
Improvement Act of 1970.
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6.
C. The 1990 Clean Air Act was the first
piece of federal legislation to introduce
emissions trading. It introduced this
approach for sulfur emissions, thought
to contribute to acid rain.
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7. The disposable diaper industry is
perfectly competitive. Which of the
following is true?
a. Since the industry is perfectly
competitive, price and quantity are at
the socially efficient levels.
b. Competitive price is higher and
competitive quantity lower than the
socially efficient point.
c. Competitive price is higher and
competitive quantity higher than the
socially efficient point.
d. Competitive price is lower and
competitive quantity higher than the
socially efficient point.
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7.D. Disposable diapers have an external
cost, to the extent that they are not
biodegradable and sit in landfills.
Producers in a competitive market
consider only private costs, ignoring
disposal issues. Similarly, consumers
just want to prevent leaks that affect
them, but ignore leaks that affect
landfills. So producers and consumers
use private costs and benefits. Social
costs are higher, so that social supply is
smaller. The competitive price, based on
private costs and benefits, is lower than
the social cost. Competitive quantity is
larger, given the larger supply, than the
socially efficient quantity.
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8. An example of the command-andcontrol approach to environmental
policy is
a. placing a tax on high-sulfur coal to
reduce its use and the corresponding
sulfur emissions (which contribute to
acid rain).
b. requiring electric utilities to install
scrubbers to reduce sulfur dioxide
emissions (which contribute to acid
rain).
c. allowing coal producers to buy and
sell permits to allow sulfur emissions.
d. allowing individuals to sue coal
producers if sulfur emissions exceed69
government-set standard.
8.
B. Command-and-control is a regulation
whereby the government establishes a
pollution target and dictates the
method to achieve the target. An
example is requiring scrubbers to
reduce sulfur emissions. Sulfur
emission permits and effluent taxes are
example of incentive-based
approaches. With taxes, for example,
the firm can choose low-sulfur coal to
avoid the tax.
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P
P
EXHIBIT 6
Demand
Social
MC
G
Private
Social MC
ATC
Private
ATC
H
1
L
K
J
C
A
F
B
Q1
E
Q2 Q3 Q4
Q
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9. The profit-maximizing firm in Exhibit
6 creates water and air pollution as a
consequence of producing its output
of beef cattle. If pollution costs are
borne by third parties, the firm will
maximize economic profit by
choosing to
a. voluntarily incur costs to reduce
its pollution.
b. produce at output rate Q3
c. produce at output rate Q2
d. produce at output rate Q4
D. The firm will produce at Q4 where
demand (MR) intersects Private MC.
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10. Use Exhibit 6 to complete the
following: To maximize social
welfare, the firm should produce at
output rate
a. Q1
b. Q2
c. Q3
d. Q4
B. The firm will produce at Q2, where
demand (MR) intersects Social MC.
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Exhibit 7
Impact of Flights on House Value
Number
Total
of Flights Profits
Value of
Marginal
Profits Wilbur’s House
1 $10,000 $10,000 $100,000
2 18,000 8,000
95,000
3
24,000
6,000
90,000
4
28,000
4,000
85,000
5
30,000
2,000
80,000
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11. As shown in Exhibit 7, if Orville has
the property right to fly over Wilbur’s
house, but Wilbur is allowed to
negotiate with Orville on the number
of flights, what will be the number of
flights?
a. 2.
b. 3
c. 4
d. 5
B. At 3 flights, marginal profits for
Orville is $6,000 and the value of
Wilbur’s property goes down by
$5,000.
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12. As shown in Exhibit 7, Wilbur has
the property right to have no planes
flying over his house, but Orville is
allowed to negotiate with Wilbur, what
will be the number of flights?
a. 2.
b. 3
c. 4
d. 5
B. At 3 flights, marginal profits for
Orville is $6,000 and the value of
Wilbur’s property goes down by
$5,000.
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13. As shown in Exhibit 7, at the
socially efficient number of flights,
what will be the market value of
Orville’s house?
a. $100,000
b. $95,000
c. $90,000
d. $85,000
C. At 3 flights, this is the last number of
flights that the marginal profits are
greater than the marginal costs (ie. the
amount that Orville’s house declines in
value)
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END
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